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Covering the Basics

David Johnson

I TURNED AGE 62 LAST summer and, as with most birthdays at this stage of life, I had a pretty good, but non-spectacular day. On my birthdays, I tend to focus on enjoying the day itself as it stands before me and, for that one day, I don’t worry too much about the future, or all the adult stuff I have to do, or problems I might have to solve tomorrow, or the problems I think up in my head that would probably go away if I just stopped thinking about them.

Not fussing about such things generally leads to having a good day. Come to think of it, I should probably have birthdays more often.

In the U.S., however, age 62 marks a unique point in personal finance. For most folks, it’s the earliest age for taking Social Security. From this point on, you’re actively choosing whether to take benefits early or opting to wait.

As most people old enough to claim Social Security know, the longer you wait to claim, up to age 70, the larger the monthly checks you get once you do claim. But of course, while you wait, you get no checks. You have to make a decision whether the more numerous small checks you’d get from claiming early would be better than the fewer but larger checks you’d get by claiming later.

The most common method to figure out the optimal claiming age involves comparing the streams of income from claiming early with those from claiming late. At some “crossover” point, the larger checks from claiming late surpass the value of benefits from claiming early. The exact crossover point varies depending on the assumptions in the analysis, but typically it occurs when claimants are in their late 70s or early 80s.

Getting grumpy. Problem is, nobody knows what future market returns will be, or the exact discount rate that accurately tells you the present value of future money, or future tax rates, all of which are important variables in figuring out a crossover or breakeven point. These future uncertainties have to be estimated. Once you’ve made your estimates, some fairly simple math tells you whether, if you die at any given age, you’d get more Social Security money by claiming early or claiming later. Then, if you have perfect foreknowledge of the exact date of your death, you can make a logical claiming decision.

In the most thoughtful analyses, these estimations have well-considered assumptions behind them, but there’s still uncertainty. Still, at some point, these uncertain projections turn into hard numbers. For most of us, numbers look exact and real, orderly and comforting. They become a mental optical illusion that allows us to forget that uncertainty doesn’t disappear when it’s turned into numbers.

The problem here is not the thoughtful analyses or the people who construct them. The analyses provide useful frameworks for thinking about one of the hardest things humans have to do: make rational decisions about the best course of action when faced with an uncertain future.

Nevertheless, I find making this kind of decision annoying—because I’d like to make the best decision possible, but knowing I’m making the best decision is impossible because the perfect decision rests on a series of future variables that are impossible to quantify with precision. The fact that many decisions in life are like this isn’t helpful. It’s as if the world wants me to be grumpy.

What’s a grumpy person to do? I reframe the decision by considering two basic questions. First, what is Social Security? Second, what can I reasonably hope it’ll do for me?

First, Social Security is an insurance program that, among other things, supplies retirement benefits in the form of a lifetime stream of income. The key word here is insurance, because insurance is a different animal from investing. When you invest money, you accept risk in the hope that the future return on your money will reward that risk. When you buy insurance, you pay money to avoid risk of financial hardship that a future event might bring you. Social Security is insurance that mitigates the risk of being entirely without income, because you depleted your savings, by delivering a stream of inflation-indexed income that you can’t outlive.

To me, one of the drawbacks of crossover analyses is they treat the income stream from Social Security not as insurance, but as an investment opportunity—a chance to use that income stream to maximize investment returns. That’s a perfectly rational way to look at most streams of income, but it ignores the value of risk mitigation that’s the central benefit of insurance. It frames the insurance offered by Social Security not as a way of decreasing risk, but as a means of accepting more investment risk.

Going for the good deal. The second question—what can I hope Social Security will do for me—is more personal. As an insurance program, Social Security was not designed to cover 100% of your retirement expenses, and for most people, including me, it won’t.

I decided to think of Social Security as a stream of income that would help cover my basic living expenses. In effect, the asset of relatively reliable Social Security payments could be matched against the ongoing liabilities stemming from my basic expenses—stuff I can’t avoid paying for as long as I’m alive.

I have a better handle on my basic expenses than I have on future market returns or how long I’m going to live. Both my basic expenses and my future Social Security income will likely increase with inflation. Social Security’s inflation adjustment almost certainly won’t exactly match the inflation in my basic expenses, but they should move in parallel and the relationship between the two won’t be derailed by market volatility, a favorable trait of Social Security not shared by many other projected income streams.

Retirement expenses obviously vary from person to person. My key point: Consider what portion of your “must have” expenses Social Security might cover at different claiming dates. I define my basic expenses as food, clothing, household supplies, minor house maintenance, health insurance premiums, car insurance, property insurance, utilities and gas for the car. I have no mortgage or other debt.

For a moment, forget about your investment accounts. Instead, think about the streams of income you have, on top of what you might get from Social Security. Some people have pensions and deferred compensation plans. Some have rental property or royalties or annuities. Some work part-time or have spouses who continue to work. I decided to think about how long I would have to wait to claim Social Security so that my benefit—in combination with my other streams of income—would cover my basic living expenses.

Because the income and health situations for people in early retirement vary from person to person, the relative value of Social Security’s insurance component also varies. At one extreme, if you have health issues and little or no other income, the insurance benefit of an immediate steady stream of guaranteed income to safely cover current expenses could be critical. Delaying Social Security to get higher future payments does you little good if you can’t pay your next health insurance premium or electric bill.

At the other extreme, if you’re doing work you enjoy, or you have some mix of steady income that exceeds your living expenses, or you have so much money in the bank that you have no problem covering your expenses, the insurance value of early Social Security payments is negligible. A higher guaranteed monthly payment in the future will be more valuable to you, particularly after you stop working and your current earned income no longer covers your basic expenses.

My situation, fortunately, is closer to the second extreme. I have two streams of income: a small rental income and my freelance work. At the moment, those two income streams almost fully cover my basic expenses. While the part-time freelance work is enjoyable to me and pays some bills now, a plan that involves “I will work forever” is not entirely realistic. The rental income, on the other hand, might last my lifetime.

I calculate that my annual Social Security benefit will be large enough that, in combination with my rental income, it’ll cover my basic expenses and a little bit more once I reach my full Social Security retirement age. Obviously, as that date gets closer, I’ll continue to monitor that projection. But at some point, when these relatively secure streams of income cover basic expenses, I’ll be inclined to claim benefits.

With Social Security to cover my basic expenses, my financial market investments will only be burdened with having to pay for “lumpy” expenses, such as another car at some point, health care issues, perhaps travel or other forms of “fun,” fixing the roof on my house someday, gifting and so forth. In my case, that remaining burden is small enough in relation to my portfolio that the risk I’ll outspend my resources is virtually eliminated, and the probability I’ll be able both to afford extra things I want and to help other people is greatly enhanced.

If that’s what Social Security, as a form of insurance, can do for me, it sounds like a pretty good deal. I accept that I can’t know with certainty which claiming decision results in the absolutely optimal outcome. But if I get a pretty good deal that minimizes financial risk, I’ll take it.

David Johnson retired in 2021 from editing hunting and fishing magazines. He spends his time reading, cooking, gardening, fishing, freelancing and hanging out with his family in Oregon. Check out David’s earlier articles.

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